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Repo cut to spark bank lending, lower interest rates

Posted by Yogesh on Tuesday, 21 October, 2008

MUMBAI: Some good news, finally. It’s just a matter of time before interest rates on home loans start coming down. Since the cash crunch has turned bankers risk-averse, they may wait a while to figure out whether the worst is over.

But at the end of the day,they will have little choice but to cut loan rates. An unexpected interest rate cut by the Reserve Bank of India on Monday was a strong signal to banks that they should go out and lend instead of sitting on cash or parking the money in government bonds.

Having raised money at high rates to battle an unprecedented liquidity crunch, banks will prefer to cut their deposit rates first before lowering interest on loans to consumers and corporates.

But they know that the one percentage point cut in the repo to 8%, the rate at which banks borrow from RBI, marks the beginning of a dovish monetary policy, with inflation becoming less of a concern. RBI had last cut interest rate in 2004.

Significantly, the announcement came just 3 days before RBI’s monetary policy and during the market hours, something that RBI rarely does. The somewhat hurried cut may have been aimed at not just nudging banks to lend but also livening up the stock market. The 100 basis point repo rate cut comes on top of a CRR reduction of 250 basis points. Taken together, these moves mark a dramatic reversal of four years of monetary tightening.

According to Deepak Parekh, chairman of India’s biggest mortgage house HDFC, “an effort is being made to bring back normalcy. Until last weekend, there was reluctance among banks to lend. And even if they did, it was at 16% to top corporates. We have to see whether the repo rate cut brings back normalcy.”

The move, which could gradually smoothen working capital flows to companies and lower their finance cost, enthused the stock market, with the Sensex hitting a high of 10,538.05 points, before slipping to 10,223.09 at close, up 247.74 points.

“Not much can be expected until companies are actually able to borrow money from banks. Wait for the money to enter the system,” said SBICAP Securities head of research Anil Advani. The Nifty gained 48.55 points to close at 3122.80. According to the treasurer of a leading bank, many banks will await RBI’s policy statement on Friday and the liquidity position on Monday before announcing a rate cut.

So far, only Union Bank of India has announced a 0.5 percentage point rate cut on home loans upto Rs 30 lakh. Though RBI has unlocked funds by cutting banks’ cash reserve ratio, dollar selling by the central bank to hold the rupee is drying up some of the liquidity. With the rupee falling against the dollar, most bankers want to get a fix on liquidity before announcing a rate cut.

According to Goldman Sachs, RBI’s aggressive mood reflects further loosening ahead. If FII outflow continues, RBI may have to allow banks to pledge more SLR securities for borrowing from RBI. On Monday, FIIs sold over Rs 800 crore.

Brokers attributed the recovery to short-covering of positions and warned that the stock market’s troubles were far from over. For one, most investors as well as traders have suffered bruising losses over the last couple of months, and these players were likely to use any upsides to trim their losses by selling their earlier investments. Also, with the rupee weakening, FIIs would be reluctant to commit money into Indian equities in a big way.

Market watchers expect the selling pressure in many mid-cap and small cap stocks to continue due to promoter-specific issues, rather than company or sector-specific issues.

“Many promoters had borrowed heavily by pledging their shares, and are now in no position to meet margin calls. The lenders are now dumping the shares to recover the loans,” said a broker.

The upswing on Dalal Street was also influenced by a recovery in key Asian markets, with South Korea, Singapore and Hong Kong indices surging 2-5%. Key European shares too, were ruling firm during the day. Source The Economic Times

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2 Responses to “Repo cut to spark bank lending, lower interest rates”

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